Corporate Governance Part 1 Flashcards
Distinguish between rules and principles based Corporate Governance
Rules based approach (e.g. “Sox”) – requires total compliance in all levels of detail. Legally enforceable. Companies become legally accountable for compliance.
Principles based approach (e.g. “UK Corporate Governance Code”) – compliance standards set by the stock exchange as opposed to the law. Companies required to comply in detail with all provisions in the code or explain (usually in the annual report) to shareholders if compliance not fully achieved.
Disadvantages of Sox/rules-based approaches?
Additional costs in ensuring and demonstrating compliance.
Compliance is seen as an “inflexible box-ticking exercise”
infringements and transgressions are punished by the state through its judiciary and not the shareholders.
What are the advantages of comply or explain?
- enables the policing of compliance by those who own the entity, making the company directly accountable to shareholders
- reduces the cost of compliance, recognizing that “one size does not fit all”
- avoids the need for “inflexible legislation”
What are the advantages of Corporate Governance codes?
- Should reduce fraud, corruption, risk and poor management
- Good governance = good performance
- Investors will pay a premium for well governed companies (‘governance dividend’)
- Good governance should increase shareholder returns (improved investor confidence)
What are the drawbacks of Corporate Governance codes?
- Process is reactionary rather than proactive (e.g. in response to major failures)
- Added red tape and bureaucracy
- Adherence to governance requirements harms competitiveness and does not add value
- It cannot stop fraud
What are the Roles and Responsibilities of the Board?
- Provide entrepreneurial leadership of the company
- Monitoring of the CEO
- Establish appropriate internal controls that enable risk to be assessed and managed
- Ensure necessary financial and human resources are in place for the company to meet its objectives
- Ensure there is effective communication of its strategic plans, both internally and externally
- Meet regularly to discharge its duties effectively
- Assess its own performance and report it annually to shareholders
- Submit themselves for re-election at regular intervals. Every 3 years.
- Appoint appropriate NED’s
- establish remuneration committee (all NEDs)
- establish nominations committee (majority NEDs)
- establish audit committee (all NEDs)
- establish risk committee (majority NEDs)
What are the main characteristics of NEDs?
- Have no executive or managerial responsibilities or power
- Are not employees of the company and are not involved in its day-to-day running
- Usually receive a flat fee for their services, and are engaged under a contract for service
- Have an important role to play in reducing conflict between executive management and shareholders by providing balance to the board
- Bring an independent viewpoint as they are not full-time employees
What are the four KEY ROLES of NEDs?
Strategy Role - right and responsibility to contribute to strategic success.
Scrutinising Role - required to hold executive colleagues to account for decisions taken and results obtained
People Role - decide remuneration of executives through remuneration committee and ensure appropriate succession planning through nominations committee
Risk Role - ensure the company has adequate systems of internal controls and risk management in place
What are the threats to NED independence?
- Employee in the last 5 years
- Existing NED, but has served on the board for more than 9 years
- Close family ties with other directors
- Significant shareholder
- MATERIAL business relationship with company in last 3 years
- Cross Directorship in other companies
What are the main advantages of board diversity?
- Allows the organization to benefit from a wider pool of talent
- A more diverse board enables a wider range of views (and more effective decision making)
- Enhancement of corporate reputation (investor confidence), signals to stakeholders that an organization does not discriminate against minorities
What are the main disadvantages of board diversity?
- Potential for increased conflict and tension
- “Tokenism” (minorities only included because it looks good)
Why is induction of directors important?
Induction is important for a new director as it will help him/her become effective in the role quicker.
Why is CPD important for directors?
CPD is designed to ensure directors have sufficient skills and ability to be effective in their role.
Why should the role of CEO and Chairman be split?
- Removes unfettered power
- Allows the chairman to be clearly and solely a representative of shareholders (no conflict of interest)
- Chairman can be more critical of executives
- Provides a clear path of accountability for the CEO and management team (answerable to chairman)
- Increases investor confidence
- Both roles are complex and demanding, In large companies, it is likely that the two roles cannot be carried out effectively by one person.
What are the drawbacks of splitting the roles of CEO and Chairman?
- Conflict - there will almost inevitably be conflict between two high-powered executive offices.
- Cost – two directors now need to be paid, instead of one
